RetireMentors

Annuities

Take the challenge: Read your annuity contract

Melody A. Juge is founder of Life Income Management™, a firm specializing in
retirement income planning and the transfer of family wealth. She is
currently in process of finalizing her soon to be published retirement guide
series, RetirementSense™. Melody is an Investment Advisor Representative with
Brokers International Financial Services, LLC, Panora, Iowa - Member SIPC. Life
Income Management™ and Brokers International Financial Services, LLC are
separate, distinct and not affiliated companies. For a free Confidential
Personal Financial Organizer and more information on Melody and her team please
visit:
www.lifeincomemanagement.com or contact Melody directly at:
mjuge@brokersifs.com.

Sometime ago I decided to take a survey to see how many people actually read their annuity contracts and understood what their contract provisions provided — and were aware of how those provisions could benefit them or potentially hinder them if not executed properly.

I was not surprised to find that most people don't read their annuity contracts. Even if they give it a try, they don't understand the contractual language of what they own.

So here is the question: Why would you place a substantial sum of money in safekeeping with an insurance company, sign a binding agreement — the application — which actually becomes part of the annuity contract and put yourself on the hook for seven to 15 years of possible surrender charges. All of this during a financially vulnerable time of life — your retirement — and then not read the contract thoroughly to understand the details of your purchase?

I think the answer is simple. It can be an overwhelming task to decipher the legalese that’s required to create these contracts. In addition, your contract may offer a variety of crediting methods which can also be difficult to understand, without thorough explanation of their features and benefits.

During one of my educational retirement round tables I challenged this point to the group. More than one person became uncomfortable. Someone said, "Are you suggesting that I can't trust my insurance agent?" I replied that they were missing the point. The point is that a large sum of money, often $100,000 or more was placed with an insurance company for the purpose of providing much needed benefits at a later date. Those benefits are fully stated and described within the legal document known as your annuity policy — and it is the responsibly of the owner of the contract to make sure they have a thorough understanding of what was purchased.

It’s not only what you’re contractually allowed to do and what the insurance company is contractually obligated to provide that is of importance. The real issue is that without understanding your contract you might inadvertently execute a transaction that could change the very reason you made the purchase in the first place.

Here’s an example of what I’m referring to: Most life-income annuity contracts have a provision that will allow for a penalty-free withdrawal one time during each contract year. A contract year is 12 full months from the issue date; don't confuse this with a calendar year. The amount allowed for the penalty-free withdrawal varies from insurance carrier to insurance carrier and from product to product.

Let's use a 10% free withdrawal for this example. If your contract has a life-income benefit account feature it will usually have an accumulation account which is often considered the cash account. The penalty-free withdrawal, if exercised, will be taken from the accumulation account. What most people don't realize is the life income benefit account is then reduced also. The reduction is taken not by a dollar amount but by the percentage — 10% in this example. Your future life income benefit is now recalculated using the reduced amount as the base, going forward, thus providing you with a lesser annual income benefit at the time of distribution.

I was introduced to a widow, age 68, who had purchased several annuities at various times from the same financial adviser. She sought me out for clarification of her benefits. I discovered that she was under the impression that she could claim her 10% penalty free withdrawal, which she was already in process of doing, each year for 10 years and then at the end of the 10 year period she could begin to take the maximum life income benefit calculated on the original illustration provided to her. Whether she actually had been told that, which she claimed she was, and her agent didn't understand the product or whether she didn't comprehend the information initially presented to her isn't the issue. The fact was she had never read her contract, didn't understand the language of the contract and was genuinely surprised by what she considered to be new information.

You owe it to yourself

This is your future income. Whether you plan on taking annual income or you plan on dipping into your annuity pot for other reasons, later on down the road you must know what you can and can't do without penalty. I believe that the power of proper retirement planning is created by having as much flexible control over your money and its use as possible. This control comes from understanding how you can manipulate, to your benefit, the provisions of the contract that you are bound to.

You must be fully aware of the details of any and all possible penalties that reside within your contract. A penalty can be defined as a cost to you in form of a monetary charge (such as a penalty for early surrender of the contract) or a contractual change which doesn't benefit you, but is created by you, inadvertently, through action taken without thorough understanding of the language and provisions of the contract.

Penalties usually fall into one of two categories: the first type of penalty is monetary, that would include but not be limited to you taking a percentage out of the contract that exceeds a penalty-free withdrawal. Different types of annuities allow for different amounts of penalty-free withdrawals. Sometimes it is a percentage, as in 5% or 10% each contract year and sometimes it may be the interest only, which is the earned interest during a contract year. Some contracts have an accrual feature that allows you to build, year after year on the penalty-free withdrawal percentage that was allowed but not taken.

Here is an example of that: If the contract allows a 10% penalty-free withdrawal starting after the first contract year, it may include a provision that allows for the accrual of penalty-free withdrawals not taken. Possibly up to a maximum of 50% of the contract. That sounds very appealing but you must know what could prohibit you from exercising that provision and if exercising the provision would affect future benefits.

If you are one of the many who have haven't read your annuity contract and don't understand the inner workings of it, you must afford yourself the opportunity to get clarification on each and every word that may be confusing to you, then you will know exactly how to maximize your benefits.

It's your money and it's sitting in an insurance product that you simply may have more control over than you think.

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